Stopping Inflation

We talked about the problem of inflation last week.  The picture above shows a good example of why inflation should be stopped.  Somebody who had $20 in 1988 could just about feed their family for a week.  I was married in 1988 and remember a food budget of $10.00 per week for my wife and myself.  If they put that $20.00 in a jar, by 2013 that same $20.00 might just make a decent meal.  This discourages people from saving and encourages spending.  

How do we stop inflation?  The best way is to slow or stop money creation.  One the the best ways to do this is to create a system where money cannot be created out of thin air.  Currently, money is primarily created out of thin air by two methods, deficit spending by governments and expansion of credit by the banking industry.

This wasn't always the case.  Traditionally, paper money was a "note" or "IOU" statement that represented a real commodity.  Gold and silver have been particularly popular.  The $20 bill used to be redeemable for an ounce of gold.  Currently, that ounce of gold can be traded for more than $1000.  That is plenty of groceries.  If money is tied to a commodity like gold or silver, in order to print more, you have to acquire more gold and silver.  That stops inflation in two ways.  The first is that it stops overprinting of money.  The second is that even if money is overprinted, there is an underlying understanding as to what the money is worth.  A $20 bill=an ounce of gold=two carts of groceries.

People correctly argue that there is now probably too much money to go back to the Gold Standard ,   However, there is no reason to not use a variety or Basket of Commodities .  Although the value of some commodities change relative to others, this is usually a slower and less drastic process than how paper (or electronic) money with no backing changes value.  An ounce of gold is still the same chunk of metal it has been for thousands of years.  However, the value of a paper dollar relative to that metal changes by the second.  I believe the biggest error people make is saying that the price of gold has changed.  It should be said that the value of the dollar has changed.

We should make all paper or electronic money exchangeable for a real asset that can be touched.  We should also require that any bank or government that creates more money should have to acquire more of that asset first.  That way, the value of money will be stable and won't be manipulated by those in power for their own gain. 

The Problems With Inflation

Inflation is a difficult subject, which is why most politicians avoid it.  Most definitions of Inflation tend to focus on one of its main effects, increase in prices.  Inflation is really an increase in the money supply relative to the number of goods being produced.   If there is more money than goods, the money is worth less (if there is too much money, it becomes worthless).  The opposite condition is called "deflation."  Deflation occurs when production of goods increases and more money is not created.

There is a general rule.  Inflation is good for whoever gets the money first (i.e. government, banks, large corporations) and deflation is good for whoever gets the money last (small businesses, workers).  Governments usually create the money, so they try to convince the populace that inflation is good.  That is because they want to have the ability to create money in order to reward constituents.  Notice that the Federal Reserve in the United States has an inflation target, not a deflation target or stability target Why is 2 percent the Federal Reserve's inflation target? Because it is. In the United States, money creation has been shifted to the banking system through creation of credit.  Banks also have an interest in creating inflation.  The more money they can lend, the more profit they can make.    Actually neither inflation nor deflation is an ideal condition.  The best condition is where the amount of money roughly matches increases in production and population.  Since this cannot be achieved perfectly, a money should go through brief periods of inflation and deflation, with the goal of keeping money stable. 

Problems with inflation--

For the individual--  Worker's' salaries do not keep up with inflation.  Workers in the United States today have seen their buying power decrease steadily.  Inflation also takes away the power of saving and investment for the average family.  30 years ago, somebody who had a million dollars or won a million dollars in a lottery was considered to have enough money to last forever.  They could be said to be rich.  Now, people who are trying to retire with one million dollars in investment accounts are finding it is not enough money for even a modest lifestyle.

For public policy--  Inflation creates an environment where the government is trying to catch its own tail with various entitlement programs.  The federal government collected little money for entitlement programs like Social Security and Medicare.  In 1975, the average recipient of Social Security received around 200 dollars per month.  What would that buy today?  Now, the average recipient receives more than $1300 per month.  The problem is that when they were workers in 1975, they only paid an amount of Social Security Tax sufficient to cover $200/month.  In fact, most did not earn enough annual income in 1975 to support a $1300/month payment later in life.  Inflation means that government has to cover that difference.  The crazy thing is that $200/month in 1975 bought more than $1300 today.  The average rent payment was only about $80 per month  Rent of Primary Residence Inflation Calculator .  Due to inflation, an $80 monthly rent is impossible today. 

Next time, we will go into some plans to stabilize currency.